Heights of Privilege

June 2, 2016. The following article by James Parrott appeared in the Spring 2016 issue of The American Prospect magazine.

If you want to learn about the latest manifestations of inequality in urban America, read the real-estate sections of newspapers and magazines and check out the photo spreads on luxury condos in new residential skyscrapers. The palatial size, lavish finishes, and breathtaking price tags of these properties are advertisements of our new Gilded Age. In the area immediately south of Central Park in Manhattan now known as Billionaire’s Row, condos at a half-dozen towers for the super-rich list for an average of $14.5 million. Buyers from abroad are common. The penthouse at 432 Park Avenue—the tallest residential building in the Western Hemisphere—went for $95 million to a Saudi. At One57, a residential skyscraper on 57th Street, the luxury penthouse was sold for $100.4 million, the buyer reported to be the prime minister of Qatar. About one-third of Manhattan condo sales since the 2008–2009 recession have been to foreign buyers or to a limited liability corporation (LLC) often used to shield the identity of the ultimate owner.

Such properties also epitomize the privileges of the global one percent in a less publicized way: They are dramatically undertaxed. According to New York City’s Independent Budget Office, property taxes on the condos at One57 are discounted by 95 percent. Although that’s extreme, it’s consistent with a general pattern of underassessment of high-end real estate that ends up leaving low- and middle-income families with a disproportionate tax burden.

The public policy decisions that have promoted and subsidized luxury development are getting new attention, thanks to concerns about the surge of foreign buyers in the top tier of the market in New York, Miami, Los Angeles, and other cities. As New York’s mayor in 2013, Michael Bloomberg argued that the influx of foreign wealth was a good thing. “If we could get every billionaire around the world to move here, it would be a godsend. They’re the ones that spend a lot of money in the stores and restaurants and create a big chunk of our economy, and we take tax revenues from those people to help people throughout the rest of the spectrum.”

Unfortunately, however, not only do the super-rich pay little in property tax relative to market value; since most of the foreign owners don’t live or work in New York even half the time, they also don’t pay city or state income tax. In fact, some of those buyers aren’t eager to pay taxes in their home countries either. A New York Times series in early 2015 tracked down some of the LLC buyers and their beneficial owners, uncovering oligarchs and other shady characters who have amassed great fortunes all across the globe, often under questionable circumstances. To no one’s surprise, such buyers have had no difficulty tapping an army of local enablers in the real-estate business eager to facilitate such transactions.

Concerned about the potential for money laundering, the Treasury Department announced in early January that it would start requiring title insurance companies to reveal the beneficial owner in all-cash purchases in Manhattan and Miami that “may be conducted by individuals attempting to hide their assets and identity by purchasing residential properties through limited liability companies or other opaque structures.” A Treasury official stated, “We are seeking to understand the risk that corrupt foreign officials, or transnational criminals, may be using premium U.S. real estate to secretly invest millions in dirty money.”

Other concerns have also arisen about the wave of purchases of urban properties by often-anonymous nonresident buyers—domestic as well as foreign—who may be mainly interested in the properties as investments. Full-time residents of chic neighborhoods now complain about a “ghost town” feel in their area because so many apartments are unoccupied most of the time. In some census tracts in Manhattan, government data confirm that 60 percent or more of apartments are vacant for ten or more months each year. Ironically, many of the complaints about nonresident owners and the low taxes they pay come from wealthy residents whose own condos are also underassessed.

The controversy over luxury real-estate development has begun to produce a political response. New York State has started phasing out one of the subsidies benefiting luxury real estate owned by nonresidents. But more substantial reforms are necessary in New York and other cities, and those changes should reflect an understanding of how property taxes came to be skewed in favor of the people who need tax relief the least.

Since property is usually taxed in relation to its value, the wealthy ought, in principle, to pay more. In practice, however, the ratio of property taxes to income invariably declines as you go up the scale.

Property taxes are typically the largest local funding source for public schools and other services—amounting to $1.8 trillion nationwide, nearly one-seventh of total taxes collected at all government levels. Since property is usually taxed in relation to its value, the wealthy ought, in principle, to pay more. In practice, however, the ratio of property taxes to income invariably declines as you go up the scale. That’s the definition of a regressive tax. The Institute on Taxation and Economic Policy—a leading state and local tax justice think tank—reports that, as a percentage of their income, middle-income families pay property taxes four times higher than the wealthiest 1 percent, and the poorest fifth pay property taxes five times higher.

With its reputation as a bastion of progressive politics, New York City might be expected to have a progressive tax system, taking all taxes into account. Nonetheless, the overall tax burden is regressive, largely due to the property tax that hits homeowners in poor neighborhoods and renters throughout the city with higher effective tax rates than others pay. And while New York’s Mayor Bill de Blasio has worked overtime to build more affordable housing, his main approach is to give property tax breaks to luxury housing developers on condition that they include a portion of affordable housing in their construction projects. The leaders of both the city and state haven’t put as much effort into making the property tax more equitable.

Analysts across the political spectrum in New York agree that systematic inequities in the city’s property taxes are traceable to legislation passed by the state in 1981 to protect small homeowners. As a result of peculiar provisions of the 1981 law, effective property tax rates (taxes paid as a percent of true market value) are now highly skewed. Most owners of one-, two-, and three-family homes pay the lowest effective rates, followed closely by owners of co-op and condo apartments. The owners of rental properties pay much higher effective rates, which they pass on to their tenants. In fact, rental properties now carry effective tax rates about five times the effective rates for condos and one-, two-, and three-family homes. These property tax inequities have a marked class and race dimension. The median income of renters is only half that of home and apartment owners; racial minorities account for slightly more than half of home and apartment owners but for three-quarters of renters.

Two major problems with the 1981 law are at the root of growing inequities. First, the law imposed assessment caps to keep taxes from rising too fast for one-, two-, and three-family homes, but it didn’t apply those caps to multifamily structures with ten or more units, whether co-op, condo, or rental buildings. As a result, the effective tax rates on one-, two-, and three-family homes declined relative to those on large apartment buildings. Second, the 1981 law required that co-op and condo buildings be valued as if they were income-producing properties—that is, rental buildings. New York City has long had “rent stabilization” protections that limit rent increases, a benefit to renters. But the valuation for tax purposes of co-ops and condos as if they were rental units resulted in assessments of those properties far below their market value. In 1997, the City Council also enacted a partial tax abatement for co-ops and condos that doesn’t apply to rental properties. Since rental buildings were subject to neither the assessment caps nor a valuation method that discounted their market value, the effective tax rate on rentals kept climbing relative to all forms of owner-occupied units.

Another source of property tax inequities is variation in effective tax rates by neighborhood. The assessment caps have had a bigger impact on assessments in higher-income and gentrifying neighborhoods than in predominantly working-class neighborhoods, where prices haven’t grown as fast. For example, the Independent Budget Office estimates that condos in swanky parts of Manhattan such as the neighborhood south of Central Park pay effective tax rates one-third those of condos in many parts of the Bronx.

The inequities in New York City’s property taxes have been widely recognized ever since the passage of the 1981 state law, but reform has remained elusive. David Dinkins, mayor from 1990 to 1993, and Rudy Giuliani, mayor from 1994 to 2001, had some interest in reform but were never able to follow through. During his three terms, which ended in 2013, Bloomberg seems not to have lost any sleep over tax inequities or income disparities.

Nevertheless, the patent absurdity of subsidizing wealthy nonresident owners has finally opened up possibilities for change. In 2013, the state legislature passed a measure to phase out the 1997 co-op/condo partial tax abatement for nonresident owners. Proposals for a “pied-à-terre” tax have also received some attention. One proposal calls for a graduated 4 percent tax on the true market value in excess of $5 million on co-ops and condos owned by nonresidents. Although it would only apply to the top 2 percent or so of nonresident-owned New York City apartments, the tax would generate $300 million to $400 million a year—enough to cover most of the cost of universal pre-kindergarten in the city.

The mere mention of the “pied-à-terre” tax proposal was enough to generate howls of protest from the real-estate community.

Every effort to tax high-end real estate draws fierce opposition. The mere mention of the “pied-à-terre” tax proposal was enough to generate howls of protest from the real-estate community. Tackling the larger problem of property tax fairness inevitably means confronting even wider resistance. For years, property tax reform has been considered untouchable in New York City because middle-class owners of one-, two-, and three-family homes have some of the lowest effective rates and likely would end up paying more. Still, in a city where two-thirds of households rent, there could be a base of support for change.

In New York, three key ingredients will be needed for true property reform. The first is a blueprint to correct the problems I’ve described in current state law. Second, to ensure that no home-owning family pays an inordinate amount in property taxes, reform should include a “circuit breaker”—a provision that limits taxes in relation to family income, administered through the local income tax. Third, tenants in units under rent stabilization need guarantees that savings will be passed on to them if property taxes decline on rental properties. Since New York City’s property tax system is established in state law, the city government cannot change that system by itself. The city and state need to act together—a difficult process even when both the mayor and the governor are Democrats.

The goal should be to reduce the disparities in effective property tax rates among residential properties. Changes should be phased in gradually—a transition period of 10 to 15 years might be necessary. Lessening the burden on rental properties can only help the city’s considerable challenge in providing affordable housing. At the same time, reforms ought to curtail unnecessary property tax breaks that have favored the biggest developers and corporate real-estate owners.

Looking across the country, two approaches top the progressive agenda for property tax reform. States and localities should introduce or expand circuit breakers (31 states and the District of Columbia already have them) or institute a homestead exemption that reduces a homeowner’s property taxes by exempting a portion of a home’s value from tax. Another commonsense step is to increase state aid to localities in order to lessen the reliance on regressive property taxes. Both the circuit breaker and the increased local aid approaches shift the tax system toward broader-based state taxes, especially the income tax. Forty-three states have an income tax, and rates are graduated in 33 of those.

Graduated real-estate transaction taxes with rates that rise along with property values also make a lot of sense. To help fund an ambitious affordable housing agenda, New York Mayor de Blasio last year proposed a supplementary “mansion tax” of 1 percent on the first $5 million of a transaction and 1.5 percent on the value over $5 million. (This would be in addition to an existing top state and local transaction tax rate of 2.825 percent.)

Pied-à-terre taxes on nonresident owners also make a lot of sense in light of the increase in the ownership of second and third homes and the acquisition of properties primarily as investments. Occasional residence by itself doesn’t contribute much to the local economy or to a sense of community. Nonresidents who don’t contribute much in other ways ought to help fund the services and infrastructure that underpin the value of the assets they acquire.

An idea dating back to the 19th-century reformer Henry George is a land value tax. This is a way to both discourage speculation and to capture some of the value that is socially generated and not the narrow result of the property owner’s investment. The progressive element here is that government reaps a dividend associated with collective contributions that make a community a profitable site for market activities. Without a land value tax or similar mechanism, re-zonings for high-density commercial or residential uses simply put billions of dollars into the pockets of big developers in cities while transportation systems and other public needs are starved for resources.

As hard as property tax reform is, it is too big a source of inequity—and of frustration with government—for progressives to ignore. Less-regressive property taxes would help make real progress in the effort to reduce the racial and class inequalities in urban America.